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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Monetary Policy

Federal Reserve Policies during the 2007-2009 Recession


Federal Reserve Policies during the 2007-2009 Recession

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Alright. So now let's see some of the decisions that the Fed made during the 2008 recession. So let's check out some monetary policy decisions during the 2008 recession. So this recession was a very special one because a lot of different measures were taken that are generally used as monetary policy. It was basically unprecedented the amount of monetary policy that went down. So during that recession, the 2007-2009, it was caused by a burst in the real estate market. Okay, the real estate market came tumbling down and a lot of things came tumbling with it. Okay, So the first thing that happened was the main cause of it was that these mortgages that were, there was a lot of sales going on of houses, mortgages were bundled and sold as securities called mortgage-backed securities. And we talk about this in a lot more detail in another video about the recession, you can look it up, just type in the financial crisis of 2008 or type in recession and look it up in the search bar and you'll find more information about the causes here. We're going to focus on the monetary policy that happened. So, these mortgage backed securities, this is basically where they took a bunch of mortgages from different people, bundled them up together, Low risk people and high risk people bundled together and sold as securities. So whenever those mortgages made payments, well, that was like a return on the investment in these mortgage backed securities. So they were made to look safe because safer mortgages were bundled with high risk subprime mortgages. There were mortgages that were given to people who were not as credit worthy and they were bundled together with safer investments to make it look okay. Okay, so ethically, that could have been a problem already. And as more mortgages defaulted. So as this real estate bubble started to crash, more and more people stopped paying their mortgages and these mortgage backed securities, that's the mortgage backed securities, MBS uh, they suffered losses and a lot of them were owned by investment banks. There were a lot of investment banks that owned had huge positions in mortgage backed securities because for a long time they were getting a lot of returns while the market was booming. But when the crash happened, there was a lot of uninsured losses uh within these investment banks. So that was a big tumbling where a lot of these banks started to show huge losses uh that basically made them insolvent and basically bankrupt. So, we're gonna talk about some things that happened near the beginning of the recession and then a major event that basically turned the recession, uh that that was a turn in the recession and then how basically it ended. Okay, so some of the first decisions that the Fed made some actions they took where they were allowing discount loans to some investment banks. Okay, so discount loans um are generally not made to, to investment banks, they were made to commercial banks on overnight type of stuff, but now they were allowing investment banks to get discount loans, which is very low interest rate loans so that they could have some liquidity. Okay, so it's providing some short term funds to the investment banks without having them need to sell new securities, create new securities and take on more risk. Okay, so they allowed these discount loans, They also loaned 200 billions of Treasury securities in exchange for mortgage-backed securities. So, these mortgage-backed securities were crap, right? They had lost all of their uh, cash flows that they were bringing in and they loaned out good Treasury securities in exchange for basically worthless collateral. Right? So this also gave the banks more liquidity uh, to use as collateral, uh, rather than having those worthless mortgage backed securities. Another thing they did was, they, this was a huge thing, is that they assisted Jpmorgan Chase One investment bank in acquiring Bear stearns, Bear stearns was going bankrupt and they basically believe that if Bear stearns went bankrupt, they would be a financial panic and abdominal effect from Bear stearns collapsing. Well, everything would start to fall and the recession would get worse and worse and worse. So, they thought, if they could save Bear stearns and have Jpmorgan Chase, buy them out. Well, then they would reduce the effects in the future. Okay, so those are some of the first things that happened. And then in september of 2008, well, the federal government took control of these public entities, uh, Fannie Mae and Freddie Mac, which were mortgage purchasing companies. Okay, so they assisted in basically uh, providing credit. And they had a big role in the mortgage backed securities and they hoped that by purchasing these companies that the confidence, our, excuse me, if these companies had gone, gone under, the confidence in MBS would have decreased even further and it would have again pushed the market into a deeper recession. So, these mortgage-backed securities, a lot of investment banks had huge positions in these mortgage-backed securities and once they started to fail, they really had nothing left. All of the value that they had was in these securities and they were now basically worthless. So in September 2008, this was a big moment in the recession, was the Fed allowed another investment bank. So at first they saved bear stearns through that purchase, but now they let another investment bank called Lehman Brothers, Lehman Brothers, they let Lehman Brothers go bankrupt. Okay, They just said, alright, you're gonna fail. We're not gonna bail you out. So, the reason they did this was they started to realize that there was what's called moral hazard in this situation. So, moral hazard is a problem when it comes to bailing you out in this situation from an uninsured risk. Okay, so moral hazard has to do with these banks having taken all of these risky investments through these mortgage backed securities. And they didn't have basically any insurance, um, to cover them. And I mean, for the most part, they didn't have the insurance to cover them. But what happened was the government stepped in and even though they lost all this money through all of these risky investments, the government stepped in and said, hey, we're gonna bail you out. Right. So by arranging the purchase of Bear stearns, the government effectively provided insurance for the risky decision making. So the government bailed them out, even though they had never paid premiums for insurance for these risks that they took. Well, they still got bailed out and that's not really fail. Right, Fair, right. It could, it could lead to future risks being taken knowing that the government would bail them out, right? It gives them this kind of idea in their head like, hey, we can take all these risks. You know, if something bad happens, the government will bail us out. There's no big problem here. And that's the moral hazard is that they don't want that kind of mentality going on in the investment community. They want safe, long term, reliable investments going on. So the final thing that happened here was in October 2008, there was what was called the troubled asset relief program, which is tarp and this is basically where the federal government provided funds to commercial banks in exchange for partial ownership. And this is an unprecedented event for the government to take ownership in some, in some public entities. Uh, excuse me, private entities like, like these investment banks. Right. So the federal government basically gave money to the investment banks in exchange for ownership positions. Okay. And it was an unprecedented action for federal government to take in that situation. Alright. But through these monetary policy decisions, the great recession was actually not as bad as it could have been. Right, well, we'll never know what could have been, but we do know that the great recession, when we compare it to say, the Great Depression did not last nearly as long. All right. So let's go ahead and pause here, and let's move on to.